The SEC charged an investment adviser with using his radio show and other advertisements to mislead investors. The adviser advertised that he had been selected to host the radio show, when, according to the SEC, he actually paid to host and broadcast the show. He also claimed to hold a fictitious “Qualified Retirement Advisor” designation. The SEC also accuses the adviser of intentionally concealing his significant disciplinary history by failing to deliver Form ADV and using internet search suppression consultants to hide his background. As alleged, the adviser also failed to disclose compensation arrangements and conflicts of interests. The principal, who also served as the firm’s Chief Compliance Officer, is also charged with operating a compliance program with insufficiently tailored policies that the firm failed to implement.
The SEC has proposed a new investment adviser advertising rule that broadens the definition of “advertising,” more specifically regulates performance information, and allows certain testimonials and endorsements. Revised Rule 206(4)-1 would broadly include any communication distributed by any means that promotes advisory services or a pooled fund and prohibits any misleading or unsubstantiated statements. The new rule would also require all retail-directed advertisements to include one, five and ten-year periods when presenting performance information. Advisers would also be able to use testimonials so long as the adviser fully discloses whether the person is a client and whether compensation has been provided. The new rule would also require approval in writing by a designated employee before dissemination. The SEC said it may rescind current no-action letters. The SEC also proposed a new solicitation rule that would require additional disclosure about the solicitor but eliminate the current rule’s requirement to collect client acknowledgements. Both rules require at least a 60-day comment period.
We like that the SEC has modernized certain areas (e.g. testimonials) and has clarified how to present performance information. We believe that clearer rules help compliance professionals and reduce the likelihood of enforcement cases resulting from subjective standards.
Just because you do not register with the SEC does not mean that you are exempt from its antifraud rules. Section 206 applies to any statement made by an investment adviser, whether registered or unregistered, that could defraud any client or prospective client.
Didn’t know that name-dropping could result in securities fraud? Any misstatement arguably relied upon by investors could give rise to Section 17(a)(2) charges of offering securities by means of an untrue statement of a material fact.
SEC fined a large commercial bank for failing to disclose that it only
recommended hedge funds that paid a portion of the management fee back to the
bank. The bank marketed a robust due
diligence process conducted by a purportedly independent, in-house research
group performing a multi-step due diligence process to select hedge funds from
an “extremely large universe.” In fact,
the bank only recommended hedge funds that paid back management fees that it
called “retrocessions.” Although the
bank disclosed that it might receive revenue sharing and the amount actually received
from each hedge fund, the actual due diligence process did not comport with
marketing promises. The bank, which is
not a registered adviser or broker-dealer, was charged with violating the Securities
Act’s anti-fraud provisions (17(a)(2)).
Check the marketing team’s enthusiasm at the door. The SEC doesn’t allow firms an exception from the securities laws for product hype, regardless of how clients/investors may perceive the statements. Rather than caveat emptor (buyer beware), caveat venditor (seller beware) governs sales of securities products.
The SEC’s 2019 regulatory agenda includes amendments to adviser marketing rules. The SEC will consider Rule 206(4)-1, the general advertising rule that prohibits fraudulent statements and specifically limits testimonials, past specific recommendations, and “black box” claims. The SEC will also re-visit Rule 206(4)-3, which regulates the payment of cash solicitation fees to third parties. Last year, the SEC took action on 23 of the 26 rules on its regulatory agenda.
Presumably, this rulemaking review has arisen from last year’s sweep whereby OCIE reported widespread marketing violations including misleading performance claims, cherry-picking results, the use of past specific recommendations, and improper claims of GIPS compliance. The rules haven’t really changed much in several decades, so a re-boot makes some sense. We recommend that the SEC consider specific standards rather than relying on a general anti-fraud rule.
The SEC fined a large asset manager $1.9 Million for failing to fully disclose that it used hypothetical back-tested performance data in advertisements. The SEC asserts that the respondent claimed that it could prove back to 1995 that its stock strategy combining fundamental and quantitative research outperformed either approach alone. Although the firm labeled such research as “hypothetical,” the SEC faults the firm for failing to disclose that its research was based on back-tested quantitative ratings for a time period before it generated its own quantitative models or research. Using the longer period helped boost the claimed outperformance. The outperformance data was used in marketing to institutional investors, RFP responses, and a white paper. The SEC also criticizes the compliance program because compliance personnel that reviewed the materials were not informed that the materials included back-tested data.
OUR TAKE: Do not market hypothetical, backtested performance. No amount of disclosure can ever insulate you from the SEC’s retrospective criticisms and analysis that you cherry-picked time periods or data. Also, compli-pros should note that marketing materials delivered solely to institutional investors are subject to the same rules as more widely-distributed marketing materials (with a few exceptions such as allowing presentation of gross performance together with net performance).
OUR TAKE: Last September, OCIE warned advisers against misleading marketing practices. It’s hard to believe that advisers could violate the testimonial rule, a clear prohibition that has been in effect for decades. If you don’t know the rules, hire a compli-pro to ensure you don’t violate the black letter rules.
The SEC’s Office of Compliance Inspections and Examinations has issued a Risk Alert citing common investment adviser marketing and advertising compliance issues. OCIE, drawing on over 1000 examinations and its recent “Touting Initiative,” cited several deficiencies: (i) misleading performance results including failure to present performance net of fees, comparisons to inapplicable benchmarks, and hypothetical/back-tested performance, (ii) misleading claims about compliance with voluntary performance standards (i.e. CFA Institute), and (iii) cherry-picked performance and misleading presentations of past specific recommendations. The SEC also criticized advertising that cited third party awards or rankings without proper explanation. The SEC urges advisers to “assess the full scope of their advertisements and consider whether those advertisements are consistent with the Advertising Rule, the prohibitions of Section 206, and their fiduciary duties, and review the adequacy and effectiveness of their compliance programs.”
OUR TAKE: OCIE generally issues these types of Risk Alerts in advance of bringing enforcement actions. Although the SEC has not generally brought enforcement cases solely on the basis of misleading performance claims, this Risk Alert may signal a change in enforcement policy.